Should you bring ‘baby bonds’ on board?

By Matthew Heimer

The quest for income continues to lead retirees and other investors into obscure corners they never thought they’d visit. As yields have plummeted on cozily safe investments like Treasurys and certificates of deposit, investors have held their noses and dived into riskier asset pools—think junk bonds and pipeline partnerships. This weekend, Wall Street Journal columnist Jason Zweig took a look at a relatively new high-yield innovation: “baby bonds” issued by business-development companies, or BDCs. The bonds offer yields that range from 5.875% to 7.375%–try getting that in your money-market fund—and baby-bond deals have raised about $600 million in the last two months alone. But the cutesy name masks some sophisticated and potentially risky behind-the-scenes financial engineering.

As Zweig explains, BDCs specialize in investing in “small to midsize firms that are being taken over or restructured or are starved for capital.” The BDCs can actually borrow more cheaply from banks, but they use the bonds to diversify their funding and to lock in interest rates over the long term. Zweig suggests that may be a better deal for the BDCs than for investors, however. The bonds trade thinly, which means investors can face unexpected losses if they need to sell early. Baby bonds aren’t secured, either; compared to owners of other kinds of debt, baby-bond investors would have a low-priority claim for repayment if there were a bankruptcy. Zweig’s ultimate diagnosis: “Approach this crib with care.”

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About Encore

Encore looks at the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities, needs and priorities of people saving for and living in retirement. Our lead blogger is editor Matthew Heimer, and frequent contributors include editor Amy Hoak, writer Catey Hill, and MarketWatch columnists Elizabeth O’Brien, Robert Powell and Andrea Coombes. Encore also features regular commentary from The Wall Street Journal retirement columnists Glenn Ruffenach and Anne Tergesen and the Director of the Center for Retirement Research at Boston College, Alicia H. Munnell.